Webinar Replay

The Global Edge: Shaken, Not Stirred: The Impact of the Recent Banking Turmoil

June 6, 2023

During this Office Hours replay, the WisdomTree Global Strategy team will discuss the key attributes of the recent banking turmoil. Within the discussion, the focus will center on how the U.S., Eurozone and Japan have responded. Additionally, the group will debate how the Treasury, global stock and commodities markets have behaved.

This discussion can be supplemented with the latest Global Edge publication.

Kat:

Thank you for joining WisdomTree Office Hours where today we will cover our global edge white paper under the topic of Shaken, Not Stirred, the impact of the recent banking turmoil. With that, I will turn it over to our global strategy team of Kevin Flanagan, Jeff Weniger, Nitesh Shah, and Aneeka Gupta.

 

Kevin Flanagan:

Thanks Kat. Good morning for those of you in the US. On the other side of the globe, good afternoon. So the title of this was Shaken, Not Stirred, and we were going to discuss in some part the impact of the recent banking turmoil, but we also want to make this a current event call as well. Certainly a lot going on and next week as well. You have the Fed, the ECB meeting. I definitely am going to want to pick Nitesh's brain on the news coming from the Saudi Arabia oil cuts yesterday. But before we get all to that, just one housekeeping note that what we like to do is to make this interactive.

So please, as we're talking here, throw questions in the Q and A. We're not of the mindset here where we're going to talk for 30 minutes and then open it up for Q and A. We want to make this interactive and answer your questions as you go along. So anything on the macro side, equities, fixed income, commodities, we're all open here, everything's open game for this discussion on a global basis. So with that, what I wanted to do is, Jeff, I'll turn it over to you first since the theme of this originally was the recent impact of the banking turmoil. I want to get your pulse on feelings here in the US on it. And then let's see, how is Europe bearing as well? Is it still a hot topic of conversation? So Jeff, let me turn it over to you first.

 

Jeff Weniger:

Sure. And again, put your questions in the Q and A and we do not rehearse this or know what any of our peers will say to try to keep this conversational. So okay, you asked me about finger on the pulse and feelings. The feeling that I get from speaking to American investors is that they don't really want to touch the small and regional banks. Some people are trying to wade in and try to pick a bottom. One of the things about the concept with respect to the "bank walk" as opposed to the bank runs, so SVB signature and so forth, those a bank runs. The thing that is heartening, Kevin, is that the bank walk seems to have stabilized in the last seven or eight weeks. When you look at the actual deposit basis on small and regional banks, it has been flat lining since the end of the first quarter.

Now, that may be disguising some dynamics where bank ABC is seeing outflows that we don't know about because it's going into X, Y, Z. That may be something that triggers future problems, but at least that has subsided. We don't know if that will continue because basically we have this massive gap that has opened up. I want to say that the average deposit rate on savings institutions is something like 57 basis points. And when I pulled this morning a three-month bill just to take a bill as an example, it was 5.36. So you're looking at about 500 basis points of gap between what you can get at your local savings and loan if you will, and what you can have in T-bills. That is the concept of the bank walk.

And then the other issue of which I don't know if I have the answer to it is of course, does what we see the vacancies in the office space for example, does that end up leading to a rise in bad debt? Where we had a situation where it was a marked to market, a duration situation that was causing trouble in let's say March, April, May in the banking system. Does it become a bad and sour loan situation? We've seen through the last 15 years or so that a lot of the commercial real estate loans that are actually physically held on a balance sheet is happening at the small and mids, as opposed to the mega banks which caught the Dodd-Frank situation. So I'll ask you Nitesh after... Well I don't know if you want to piggyback on this, but we have that OPEC decision. We believe that that is relevant to this call. So why don't you go ahead and go that direction.

 

Nitesh Shah:

Yeah. So OPEC, they had their ministerial meeting on Sunday. So it is a day when markets aren't generally open, but if you've ever observed in these OPEC events, they'll leave you on suspense to the very last minute. It's very dramatical and you don't know exactly what time they're starting the meeting, what time they're supposed to end there and what time the press meetings will be in between. They have some loose guidance, but they tend to keep everyone waiting. This time, while the market was expecting just a rubber-stamping of exact same quotas as last month, we were quite vocal in saying that they will seek to cut production one more time because the price of oil had fallen way below where it was prior to the previous cut. And the reason they were cutting production is to increase price. I know OPEC stated...is to balance market supply and demand, but in reality they're targeting price.

Most OPEC countries, they're highly dependent on oil revenues for their government expenditure and their so-called fiscal break evens are as in the price of oil that they need to make the government expenditures match their revenues is way north of a hundred dollars per barrel for most countries. You have some countries like Iran where you could talk about sort of $500 per barrel because of its expenditures. So the pressure on most OPEC countries was higher, but the key country that matters is Saudi Arabia because Saudi Arabia is the largest oil producing country within the group and it has most of spec capacity and therefore it can dial up or dial down its production in a manner that can meet market needs. And Saudi Arabia had been very vocal in saying it's unhappy with this current situation. They're looking at the depth of short sellers in the old markets, both in Brent and WTI and we're providing warnings to the market that they're being overly bearish and that they will readjust the market. And that's exactly what they delivered.

Now, Saudi Arabia pretty much went it alone on Sunday. None of the other OPEC nations are actually pledged for any cuts. So it's almost like a voluntary cut by Saudi Arabia, but by 1 million barrels per day. It's a hefty number and it takes Saudi Arabian production to the lowest level in several years. The other interesting thing that happened during that meeting, I think it was an OPEC reality check because OPEC had been living under this pretend environment where they've set all these benchmark levels that each individual country's maximum production capacity is, but they clearly weren't right. A lot of these sub-Saharan African nations had baseline levels that were way higher than the work they can achieve. So even if they're pumped out at maximum capacity, they will never hit those levels and therefore... And they're calculating their quotas as a cut from those baseline levels that were basically imaginary. They've been all reassigned, they've been reassigned to much more realistic levels. But in addition to that, the United Arab Emirates, which had been investing heavily in oil assets in recent years, actually seen this baseline level adjusted upwards.

So what does this mean at net? It means that the United Arab Emirates can probably actually produce more in coming months. Saudi Arabia, we are producing less by that 1 million barrel per day. Some Sahara African nations that saw their baselines cut, they had been assigned a smaller cut within the group. So net neutral for those. All in all, it means that 1 million barrel per day headline number is probably less than the 1 million barrel per day headline number. Right now, oil is actually slipping a bit. Oil prices rose on the open on Sunday and continue to rise yesterday, but right now slipping once again. Because the supply cuts aren't that deep. And also the bigger concern is demand softening elsewhere. In China as one of the largest energy consumers does look like it's continuing to slow down and there's not that much more stimulus that the Chinese government is offering at the moment. So oil is looking a little weak right now.

 

Kevin Flanagan:

We've gotten a couple of questions I saw, Jeff come in and one of them from Jonathan was asking about the fed's view of the banking crisis and what that could mean going forward. I think it should be a good way to bring Aneeka into the conversation and we'll pivot back to the Fed. But I wanted to pivot to the ECB first on this note. Going back to the banking turmoil from what we had seen. Obviously Jeff, you alluded to the regional banking names here. Arguably the name that was involved or names in Europe were much larger than what we had here in the US and waiting for the ECBs response. So dovetailing off of Jonathan's question about the fed's thoughts, what's the ECB thinking? So has the ECB changed its narrative now that we're a couple months away or removed from say some of the bigger concerns that we had in the immediate outbreak of the banking turmoil here. And of course what happened with, shall we just call it a very large bank in Switzerland?

 

Aneeka Gupta:

Yeah, that's a great point Kevin. Just tying it in with Nitesh's comments, we've seen energy prices come off and that's clearly been helping the ECBs inflation story. So we've had headline inflation in October being as high as 10% and that's now corrected all the way down to 6.1. And that's the most recent data point we received this week. Yet core inflation continues to remain quite sticky at 5.3%. It has come off since the April data print of 5.6. Yet comments that we've been receiving from ECB members continue to reiterate that they find inflation uncomfortably high. They clearly have a lot more room to go until we are able to bring inflation comfortably down to the ECBs 2% target level. We do expect two more rate hikes to follow by the ECP of a magnitude of 25 basis points.

In terms of the impact of the banking crisis, what was quite evident from the ECB's the BLS, the lending survey that we got at the end of April. It clearly showed that even before the banking crisis took hold, European banks were tightening their lending standards and even as an aftermath of what took place in the US and also the takeover of Credit Suisse, we expect lending standards to tighten even further. So we do expect after a pretty strong run in the first quarter of this year, we are likely to see a deterioration of growth for the European Union. More importantly, we've now seen Germany, which accounts for nearly 29% of Eurozone GDP now actually report that Germany has been in recession. DeSantis, which is the official statistical agency, had to revise the GDP prints that they had given for Q4 of 2022 and Q1 of 2023. They had to revise it down and hence we've had two consecutive quarters of negative GDP prints and that clearly shows if the biggest economy in Europe is stagnating, that is going to have ripple effects across the economy.

Kevin Flanagan:

I think just bringing it back to the Fed for a minute, Jeff, you had it up for a second. If you could call up figure two... On the global edge piece. I think that would summarize what's happening here on this side of the Atlantic. The Fed came in pretty aggressive initially here and they put in the new bank term funding program and essentially what it did was it allowed banks to come in and borrow at the Fed. There you go. And essentially using treasuries, mortgage backs, agencies as collateral at par value and you could probably make the argument that would've helped a great deal, the signature and the Silicon Valley banks here in the US if they could have used and borrowed at par the collateral that they had rather than the mark to market losses obviously due to the rise in interest rates.

So what this shows is the various lending facilities at the Fed on their balance sheet and as you can see on the left, you add a surge over 300 billion to begin with. But as we've moved out from say mid-March, you can see how these facilities are really not showing anywhere near the same usage as they had before. And that's exactly what was intended to be. You were there, the Fed was there immediately to put this backstop in place and since that time you're not seeing anywhere near the same usage. That being said, this chart doesn't bring you up to the date to some of the latest numbers just due to when it was actually published. There're still banks utilizing these facilities out there. You're not 300 billion but you are still seeing every week or so something in the plus column on that. And what it has done, it's created an environment of stability in the funding markets as well.

And that's something that we touched upon in the piece also, but what does it mean for the Fed. And Aneeka, I think you really hit the nail on the head because what you said about tightening credit conditions in say the Eurozone is exactly what Powell and company are focusing on here. So the big debate is whether or not the Fed is going to raise rates next week. I think they're the day before the ECB if I'm not mistaken on June 14th, but that they would come back in July. Maybe we'll touch upon that in a little bit as well. Powell's not really a stop and go policymaker, he's a student of history. He was not, I don't think in favor of following policies. We saw earlier in the Fed where they would come in, stop, pause and raise rates again.

I think Powell is more of the ilk that you just keep going, then you stop. When you stop, you stop. That's it. So it'll be interesting to see that data will have to get them to go. In other words, if they skip in June for the Fed to consider then re-upping and raising rates again in July. A data dependency, the bar has really been raised on that front and it's going to be the labor market and it's going to have to be inflation. If those numbers point in a bad direction for the fed, maybe then they would consider restarting rate hikes. But right now I think our base case, the best way of putting at it, we're either at or real close to the end of Fed rate hikes here in the US and it's really a meeting by meeting basis. I also wanted to touch upon the question that Luke asked while we have it out there because it was funny when we started writing this piece, the debt ceiling was very much in the headlines and now it's receded that President Biden has signed that into law.

But there were some interesting aspects to the debt ceiling, let's call it saga for lack of better way of putting it. And what Luke is asking, could the deposit outflows have had any relation to what was going on in the TGA? Which is the treasury general account. Think of that as the treasury's bank account basically at the Fed and it dropped to some very, very low and almost alarming levels. So it was getting to the point I saw at one instance late last week, a 37 billion, which may seem like a lot. But when you're dealing with the amount of outflows or expenditures, treasury had to deal with not just on the debt but also just normal spending it really provided no cushion whatsoever. And that's that drawdown and what's going to happen now, and this is what's going to be interesting to see with respect to deposits. And Jeff, maybe I'll bring you back into the conversation on this that it's not over yet.

Okay, so what's going to happen, okay, T-bill yields rose in a pretty visible fashion as we were getting closer and closer to the X date for the debt ceiling. And that was because treasury bills have that unusual maturity schedule. It's not like a two-year note, a 10 year note that it's either the 15th or the 30th or the 31st of the month. T-bills essentially mature every week of the month. So obviously those bills that were in that potential negative zone of concerns about the X date being breached, you saw yields rise anywhere from say 50, 75, even a hundred basis points. Now they've come down. So what has happened is now you're seeing T-bill yields here in the US reflecting more where the Fed funds rate is five to five and a quarter, which makes a lot of sense. Believe me, I'm getting to a point here Jeff, don't worry.

But what's important to remember is treasury has to build up that TGA. That 37 billion needs to go up and there's some estimates, treasury wants to get that to four or 500 billion. They don't do that in the coupon market with coupon issuance. They want to keep that steady, they don't want to rock the boat there. So T-bills will be the workhorse. So what investors can expect to see as we move further into summer into Q3 is probably a visible increase in T-bill issuance. So A, you're going to have the supply. B, you're going to have at a minimum five to five and a quarter percent rates on that. So the question Jeff, I'll pose to you is you're going to have this newfound supply of T-bills with rates over 5%. Is there any concern that bank walk becomes a bank jog as we go forward?

 

Jeff Weniger:

Oh, yeah. Well you could have the bank jog and then you could also have the NASDAQ jog too from this concept. Whereby the system now is an opportunity cost system. Price of apples goes up so I purchase oranges. And in this case the ability to get a five handle on a money market fund goes back to that trickle out of outflows from the 5 trillion deposit base in the small and regional banks. And what I've been trying to get my mind around is I'm looking at this market where... And I'm talking about the stock market now and I'll ask Aneeka see what her instinct is on this one because we don't have all of the answers, but it is intriguing and fascinating. Which is that in 22, anything like a tech relative to Staples type barbell or anything like that NASDAQ relative to an equal weighted 500, something like this or an equal weighted Russell 1000 was tell me what direction interest rates are going and I'll tell you whether or not you want to be in communication services in tech.

And boy oh, boy was that... That was what Aneeka 18 months of this? Just wake up in any given session, the long bond is sold off. I'll tell you exactly what happened in the NASDAQ today. And that seems to have broken, that relationship of late. Where if you look at for example, the long bond that yield has been ever so gently backing up for Kevin, what do you think, four or five weeks or so on the long bond? And what's the only thing working in this market? Silicon Valley. Inside the confines of the US broad market. Now that's not to... I don't want to take away from the LVMHs of the world or Japanese equities which are performing famously, generally speaking of late. But here we are with a market where it was supposed to be, okay, well if you've got the Fed at five to five and a quarter with maybe this fits and starts thing where they're going to maybe not do anything in the June meeting, continuing the July meeting or something. I should be selling off the NASDAQ in response to that, but it's not happening.

So I'll ask you Aneeka, is it that there's some sort of haven concept? This is what some people have told me, I don't know whether or not I agree with it. So I'm asking you whereby the Apples and Microsofts and alphabets of the world are what I'm seeking shelter in because I'm concerned about this matter or that matter. And that therefore those are being pulled up. Those are propelling the Russell 1000 to new highs, but that market breadth is deteriorating. Most of these names, the other thousand names are not participating. Or is it truly what I keep reading, which is AI, AI, AI, AI. Go ahead and give me alphabet and forget everything else.

 

Aneeka Gupta:

Yeah. It's something that's really puzzled the market, how we've had this massive rotation out of value purely into tech. But that breadth is what is very concerning because the breadth of the market is extremely narrow. And it's like you said, Jeff, investors are essentially seeking solace in these very, very high quality names. So stocks with high return on equity, high return on assets and strong cashflow is what investors want to be allocated to at this point in time. And obviously quality is getting expensive and at the same point in time you need to keep in mind investors have been calling for a Fed pivot since the start of the year. We've already reached the halfway mark, we still haven't got that pivot and now we're at that critical point where it's skip or miss and then hike again in July. So I think it's important to note that investors really do understand that as we go forward, the data is going to deteriorate.

Why they're seeking solace in these very few profitable technology firms is because they've been able to navigate themselves better than the other companies. They've been quite prudent in terms of cost-cutting. They've been a lot more profitable in this environment and hence they've essentially been, they've benefited from investors globally. On the other hand, if you look at those very well-known value oriented sectors and stocks such as energy and financials. Financials got battered during the banking crisis, whereas the energy stocks are essentially doing poorly as an after effect of energy prices coming off. And those stellar earnings results that we saw in 2022 are not getting replicated in 2023. I think we've reached a point where investors are questioning how much more do we have to go in this rally? But the truth is this is the only place to take refuge when investors are... It's getting even more evident that the macroeconomic data is deteriorating as we continue to proceed further.

 

Kevin Flanagan:

I wanted to jump on that point for a second, Aneeka. By the way before I go that again, I'll transition to Nitesh. Just came across the screen. The US just lifted the 4817 week bill sales by 42 billion. So as we're speaking here, treasury debt managers just raised the amounts by 42 billion. The replenishing of the TGA is about to begin, but Nitesh, we joke about it a little bit here, tongue in cheek. This widely anticipated recession, where is? It hasn't quite shown up here yet in the US. Where of the camp you are probably going to get one or two negative or zero quarters of GDP, but I'm just wondering from a global perspective because it's, and I think Aneeka to your point, some of the macro numbers are beginning to deteriorate. Not in the labor market here per se in the US but ISM, manufacturing services. You've seen it on the S and P manufacturing and services purchasing managers reports as well. How is that impacting, say, demand, let's call it for industrial commodities. Now you touched on oil, but what is going on in the industrial commodity space?

 

Nitesh Shah:

Yeah, great question. And I think you're right. The global picture is a bit more nuanced. Not every country around the world is moving at the same speed. China is certainly disappointed. There's lots of hopes for its reopening at the beginning of the year to deliver a lot more results. And what we are seeing is a bit of a weakening there. Even if you look at the purchasing manager industries, we started seeing a period of improvement and then last month was quite a drop. So there's surprises to downside. And I think once again, China hasn't delivered as much stimulus as it potentially could have done. And certainly it's very different to say 2008 when there was stimulating with no restraint at all. And possibly that's the artifact of looking at the developed world countries and saying, look, if they've got a huge inflation problem as a result of stimulating and reopening, we can just avoid that by not pushing on the accelerator that hard in the first place elsewhere.

As well as Aneeka mentioned, Germany in a recession, technically in a recession. There's lots of parts of Europe that are pulling down quite rapidly. Once again pointing to the purchasing manager industries. What does that mean for the poor commodities? Once a very dependent on manufactured goods because there are big source of the demand for energy for metals and it's clear that their prices have been declining. The metal prices based metals have been declining for close to a year now really. If you look at things like board indicators, like composite lead indicators, they've been tanking off and in industrial metro prices, they followed suit. And that weakness has been clear for a while. The more prints we get on PMI data is the worst it's been getting. But if you look at the actual units of metals being consumed, actual demand units. You'll be thinking, looking at completely different data sets, but these numbers almost don't talk to each other at all.

Yes, industrial activity is falling away, but demand for metal units are actually increasing. But one of the reasons why is that we are seeing a secular shift. We're seeing a lot more spending on metals and usage of metals in energy transition sources. So building out of batteries for cars, building out of grid infrastructure for electrifying energy systems. And in fact China has been using this opportunity really tactically while demand from traditional industrial sectors have been weakening, they've been accelerating the expenditure on grid. So they've been building a lot more electrical grid infrastructure knowing that they're going to have to electrify their vehicles over the coming decades. So it is all quite